With the Fed expected to ease, doubts arise over whether rate cuts will help

  • Markets are widely expecting the Fed to cut short-term interest rates by at least half a percentage point over the next month or so.
  • Some doubt whether the cuts will work or are even necessary in the current environment.
  • “The important thing to understand is that the Fed can’t fix this problem,” said economist Paul McCulley, who called for a “mosaic” of responses.

Financial markets and the White House are demanding interest rate cuts from the Federal Reserve that may not work and may not even be necessary.

As traders ramp up their bets for central bank easing, there’s an ongoing debate about whether the Fed should accede to the pressure with as much as a full percentage point cut this year, or wait to see whether the jangling nerves over the coronavirus subside.

The market’s expectation now is for either 50 or 75 basis points to be sliced off short-term borrowing rates by April. Ultimately, if the market and President Donald Trump prevail, rates will drop close to where they were during the financial crisis that ended 11 years ago.

“There’s no need for that. Rates have already fallen. How much lower do you want the 10-year note to go?” said former investment banker Christopher Whalen, founder of Whalen Global Advisors. “The market’s like a 2-month-old child. Every time it cries, it wants to be picked up. Sometimes you’ve got to leave the baby in the crib.”

Rate-cut calls intensified late last week and into Monday as the Dow Jones Industrial Average lost 12% — $3.8 trillion in market value — and government bond yields hit a dizzying succession of new lows. Even amid Monday’s violent market rally, expectations remained high that the Fed would come through with an ambitious policy response.

Goldman Sachs, for one, said the Fed likely would cut 50 basis points this month and may not even wait for its March 17-18 meeting to do so.

That view was backed up around Wall Street; Bill Nelson, the chief economist at the Bank Policy Institute, a nonpartisan think tank, said he thinks the Fed and other global central banks will make a joint announcement Wednesday morning at either 7 a.m. or 8 a.m. Nelson based that call in that it would be consistent with the coordinated moves done during the financial crisis, and he sees the potential for a 75 basis point cut.

“When the Committee eases policy it judges the effectiveness by the market reaction. (By contrast, when the Committee tightens policy, it wants to avoid surprises),” Nelson wrote in a blog post. “The only way to get a positive market reaction is to deliver more than expected.”

While the question seems settled that the Fed is poised to deliver a strong move in monetary policy, it’s less clear how effective or even necessary it is now. 

After all, as Fed officials have pointed out, the longer-term impact of a virus-induced slowdown is difficult to gauge. Even as Wall Street melted down last week, the economic data was largely positive as the Citi Economic Surprise Index was tracking around a two-year high of how reports were holding up against expectations.

That raised some doubts as to whether the Fed needs to conduct an intervention.

“The Fed has no role to play here,” Komal Sri Kumar, president of Sri-Kumar Global Strategies, told CNBC’s “Squawk Box.” “So to the extent that it reacts at all, it is irrelevant. It shouldn’t be happening.”

Fed rate cuts are generally tailored to demand shocks that cause a slowdown in consumer and business activity. Thus far, though, the coronavirus scare has been most felt on the supply side, with worries rising over whether China, the world’s leading exporter, can get its goods out from beyond its shores as factories close and shipping lanes see less traffic.

Should the supply contraction intensify, it could, however, bleed over to the demand side.

Source: https://www.cnbc.com/2020/03/02/with-the-fed-expected-to-ease-doubts-arise-over-whether-rate-cuts-will-help.html

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